Does the market must be concerned about AI adoption?

Good morning. President Donald Trump lashed out at Fed chair Jay Powell yesterday after Powell emphasised the risks posed by tariffs in a speech on Wednesday. Before Trump, it could have been unusual, and even alarming, for a president to openly rail against the Fed chair. But the market appears to be well prepared for such skirmishes: the S&P 500 was flat yesterday, and yields on the 10-year Treasury only ticked up 5 basis points.

Unhedged shall be off for Easter Monday, but back in your inboxes on Tuesday. Email me: aiden.reiter@ft.com. 

AI adoption

Big Tech has had a rough yr: the Magnificent 7 stocks are down 22 per cent, and semiconductor stocks have taken a beating. With the exception of the January wobble attributable to Chinese AI upstart DeepSeek, this appears to be more about market volatility than dents within the AI narrative. 

Still, the specter of slowing adoption is value watching. Sam Tombs at Pantheon Macroeconomics points out that in accordance with the recent regional surveys from the Federal Reserve, services businesses expect to dial back on IT and capital expenditure, having already cut spending in prior months (chart from Tombs; the capex intentions trend is expressed as a median of ordinary deviations relative to its 2015-2024 mean):

The most plausible justification for that is fear of slower economic growth. Most firms haven’t found a use case for AI yet, and the very best models (ChatGPT, Gemini) have free versions. If you’re the IT manager at a medium-sized company, with a possible recession looming, do you actually need to approve a giant AI line item?

Another explanation is that this might just be the brand new technology lifecycle in motion. Other historical tech adoptions have also had moments of market underperformance and lower uptake, says Joseph Davis, chief economist at Vanguard and creator of an upcoming book about tech cycles: 

It’s not at all times a straight line — there are hiccups along the way in which . . . In every cycle, the tech sector underperforms for a major period. (The) market underestimates latest entrants, while (firms) ask: why are we putting money on this tech stack when we will go on cheaper tech stack in the long run? We saw this with electricity (and other technologies).

Then there’s DeepSeek. The Chinese company’s low-cost models demonstrated that end users don’t necessarily need the very best at school, and cheaper offerings may come from smaller players within the not-distant future. That could justify going more slowly on capex and adoption spending now.

Even with falling expectations, many analysts see this as just momentary turbulence, and expect high adoption going forward. Here’s Joseph Briggs at Goldman Sachs:

The real need of AI-related capex from an end user perspective remains to be seven years off. Just 7 per cent of firms currently report that they’re using AI for the regular production of products and services. While now we have seen a pullback in capex expectations more broadly, I’d take into consideration this as being separate from the A theme, but relatively related to a near-term headwind to investment related to trade policy uncertainty.

Goldman still forecasts $300bn in AI-related investments by the top of 2025. But, as Briggs told me, that number relies on AI-exposed firms’ revenue forecast revisions. As the outlook worsens, AI spending will probably drop, too. 

The AI narrative will not be dead. The market and business pullbacks appear like an example of the familiar non-linearity of growth in latest technologies. But if the US enters a multi-quarter recession — and AI customers really begin to cool their jets — that would change.

Friday interview: Brent Neiman

Brent Neiman is a professor on the University of Chicago Booth School of Business and recently served because the assistant secretary for international finance within the US Treasury department. Earlier this month, he made headlines when the White House’s ‘reciprocal tariff calculations misleadingly cited research done by Neiman and his colleagues. Unhedged spoke with him about that calculation, the worth effects of tariffs and the long run of the dollar.

Could you walk us through the research cited by the White House?

The paper was written to measure the pass-through of the primary Trump administration’s 2018 tariffs into prices. At the time, there was a number of discussion of how much foreign countries would pay for the tariffs, relatively than the US. Theoretically, there’s nothing incoherent about that — it was possible that foreign exporters would scale back their prices to offset any imposed tariff. But it was also possible that there’d be little or no change in pricing, forcing US importers or consumers to cover the tariff.

We decided to do an empirical evaluation on this query, using data meant to represent the complete basket of US imports. We found that US importers paid around 95 per cent of the 2018-19 tariff. For example, if there have been a 20 per cent tariff, there could be a one percentage point reduction in the worth charged by foreign exporters, and a 19 per cent increase in the costs faced by US importers. 

We also checked out the worth effects of Chinese retaliatory tariffs against the US. Interestingly, there was not the identical effect. We found that US exporters dropped prices by more in response to China’s tariffs than Chinese exporters did in response to US tariffs. So in some sense, US exporters paid a greater share of Chinese tariffs than the Chinese exporters paid of the US tariff.

Finally, we traced it through as best we could to retail prices, using information from two large US retailers. Our research showed that pass-through was actually much lower for the retailers. One of the explanations could have been tariff front-running by retailers and suppliers, or because there was a shift in supply away from China’s goods towards countries without US tariffs placed upon them.

We would like to get to the implications of that, but first we wish to ask more about how the White House used your research. What did they use? What did they get right, and what did they get mistaken?

At a high level, I feel crucial thing that they got mistaken is to base trade policy across the goal of eliminating bilateral trade deficits. If you look within the numerator of their tariff formula, it’s a measure of bilateral trade imbalances. There are many explanation why bilateral trade imbalances could arise — different levels of development, or comparative advantage, or any variety of other aspects — that don’t have anything to do with “unfair” practices.

Our research seems to have shown up of their calculation of tariff pass-through. The wording that the White House used was they needed the pass-through of tariffs into import prices to make their equation; elsewhere they described it because the “elasticity of import prices to tariffs”. In their methodology, they cite our paper near that a part of the equation. But then the actual number of their formula is 25 per cent, which is far lower than the 95 per cent pass-through we found.

What do you imagine the worth flow-through shall be this time around? 

I feel there are some changes that may end in a better pass-through. There is a lot uncertainty, as , but there’ll likely be less scope for substitutes. For example, Vietnam was initially hit with a really high tariff rate. While that’s lower now, that implies that it’s going to be less feasible for our sourcing to shift from China to its neighbours.

In our original paper, we also speculated that there have been broad expectations that the trade war wouldn’t last long, giving businesses the flexibility to construct inventories before tariffs took effect. That could have played a job in restraining price increases in 2018. But that seems less more likely to hold now.

Also, the size of those tariffs is off the charts, at the least with respect to China. That shall be salient to consumers and each pricing manager within the country. Research suggests that the salience of a price shock really matters. So on this case, I feel that it is perhaps easier for firms to justify price increases, since everyone knows what’s happening. It also is perhaps something that firms need to absorb given the size. If there’s a small tariff, you would possibly expect some margin compression; that is such a giant tariff, it’s hard to assume that margin adjustment could cover very much of it.

Finally, coming out of Covid, we saw that there have been all styles of shortages, often from non-linear bottleneck effects, where key components were missing. This led to cost increases. These tariffs are so broad they usually’ve been deployed with such speed that something like that would occur again.

We’ve began seeing some concern available in the market that the brand new tariff regime will end in foreign purchasers turning away from the dollar. You’ve done a number of research on the dollar; could you share your thoughts on its future?

I feel it’s helpful to take an expansive view on the role of the dollar. The dollar is disproportionately utilized in foreign reserves, import and export invoicing, to denominate external bonds, and in foreign exchange trading, amongst other uses. There are strong network effects between these uses. So I feel it’s reasonable to be cautious in expecting anything to alter too rapidly by way of the dollar’s role. 

There is a priority that, with the recent volatility and uncertainty around trade policy, the US more broadly could also be viewed as less dependable. I do worry that that could lead on foreign investors, and the counterparts in all of those roles of the dollar, to decide on other assets over dollar-denominated assets. 

But we must be humble. There’s principally just one historical data point that now we have on a rapid shift away from the world’s dominant currency, and that’s the transition from the pound to the dollar. We have conjectured that the dollar’s prevalence is as a consequence of strong rule of law, or deep in liquid markets and sound institutions. But we just don’t have many observations to have a look at.

One of the advantages of getting the Treasury be the reserve asset of the world is it ends in lower Treasury yields. How will the trade war affect the debt outlook?

One of the ways the trade war will impact US debt dynamics is even simpler than questions around dollar dominance. Tariffs are more likely to have a really negative impact for US growth. At the top of 2024, economically speaking, we were in a very strong position: growth and productivity numbers looked great, unemployment was very low. We have now seen sell-side research economists at Goldman Sachs and other banks say that the recession risks are nearly 50 per cent, and even above that. Slower growth has implications for the dimensions of the US debt relative to GDP.

What else is in your mind at this moment?

I feel one thing that is actually necessary is the foreign policy implications from tariffs. I’m an economist, so I’m generally focused on the economic impact of those policies. But on this case, I feel the damage could also be even worse by way of our foreign policy and global standing. I just spent three years within the Biden administration. In my role, there was an actual diplomatic component to the job. I spent a number of time working with foreign countries on all styles of non-economic issues, like working with poorer countries to fight the financing of drug trafficking, terrorism and financial fraud, or to stem migration flows to the US. I have a look at the various countries that we’re now tariffing, and I worry it’s going to keep them from working with us, or doing in order enthusiastically, on these critical issues.

Correction

I incorrectly described the non-model approach to calculating the term premium yesterday, though the numbers and graphs are still correct. The approach involves the yield on three-year one-month — not inflation swaps, as I wrote — which is more accurately described as a risk-free asset related to expectations , not inflation. Subtracting that series from the 10-year to 10-year forward rate gives the measure. My apologies.

One good read

Class credit.

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